Balance of Payments 2.0

Question 1

What does the capital and financial account do?

Answer 1

tracks investments

Question 2

What is in the capital and financial account

Answer 2

• FDI
• hot money flows

Question 3

Define FDI

Answer 3

investments made by a firm in one country into a firm in another country to gain control of that country

Question 4

Define hot money

Answer 4

when foreign investors place their spare cash into the foreign banks that have the highest interest rates

Question 5

Factors that influence the current account

Answer 5

• exchange rates
• relative inflation
• productivity and costs
• quality
• growth (national income)
• protectionism

Question 6

Significance of global trade imbalances

Answer 6

• investments (via cap and fin account) are usually used to buy government bonds
• power then to influence other country’s policy, as they could demand money back have power

Question 7

Impact of current account deficit on AD

Answer 7

• negative trade balance (imports>exports) decreases AD
• lower real GDP = lower living standards and higher unemployment
• (depends if deficit is small % of GDP or spare capacity)

Question 8

Impact of current account deficit on exchange rates

Answer 8

• more imports = supply pounds
• less exports = demand less pounds
• depreciation = less investment = further supply
• decrease living standards

Question 9

Impact of current account surplus on AD

Answer 9

• appreciation and positive trade balance e.t.c
• possible lower living standards for domestic as country make goods to export

Question 10

Measures to reduce imbalances on the current account

Answer 10

• expenditure reducing policies (expenditure all together, including imports)
• expenditure switching policies (consumers switch from imports to domestic goods)

Question 11

Two main expenditure-reducing policies

Answer 11

• raising income tax
• decreasing benefits
• reducing overall expenditure reduces import expenditure = improved current account deficit
• (but reduces living standards)

Question 12

Two main expenditure-switching policies

Answer 12

• trade barriers
• low interest rates (depreciation - imports more expensive SPICEE)

Question 13

Supply side policies to reduce current account deficits

Answer 13

• reducing corporation tax (lower costs = lower prices and investment)
• increased government spending (education)
• reducing minimum wage
• right shift of LRAS or SRAS decreases price level